Economic Notes 7-29-13

July

29

All eyes are on the last week of July for Fed comments and economic numbers. However, last week had its fair share of releases as well:

(+/0) Durable goods orders for June came in a bit better than expected, at a gain of +4.2% versus a consensus increase of +1.4%. The surprise was led by a +31% increase in non-defense aircraft orders during the month, so, removing spottier defense and aircraft, core durable goods order growth rose +0.7% (relative to an expected gain of +0.6%) and May core growth was revised up a percentage point to over 2%. Core cap good shipments fell -0.9% in June, which underwhelmed based on the forecast of +1.1% growth. This latter measure is somewhat disappointing, as shipments translate into the government’s GDP estimate…something that appears to be shrinking by the week insofar as Q2 is concerned (now stand to be somewhere between 0.5-1.0%. Inventory investments for June were generally in line with what was expected.

(-) The Richmond Fed manufacturing index took a slight turn downward this month, falling from +7 in June to -11 in July (compared to an expected +9 reading). New orders, shipments and average workweek length all declined, while employment remained unchanged with a neutral ‘zero’ score. This region performed much worse than the Empire and Philadelphia Fed surveys that showed more encouraging characteristics; however, the Richmond district, that encompasses the greater Washington D.C. metro area, tends to reflect defense spending to a greater degree (and we know that’s not been a solid contributor to growth as of late).

(+) The final University of Michigan consumer sentiment survey results were revised up positively, from the initial estimate of 83.9 to 85.1 for July (forecast being 84.0)—to a new high for sentiment in the post-recession period. For the month, consumer expectations about the future rose a bit, while assessments of current conditions fell by a small amount. Inflation expectations fell slightly (one to two tenths of a percent) for the short- and long-term periods, hovering just below 3%. Consumer sentiment is certainly continuing to improve, although it is fickle and news-based. From a broader perspective, higher readings here ultimately translate to better buying patterns and economic bullishness—both of which have been difficult hurdles in recent years due to job concerns and investment market volatility all too fresh in many minds.

(-) Existing home sales fell -1.2% in June (+15% year-over year), which surprised on the downside relative to an expected gain of +1.5%. The decline in sales of single-family homes and condos/co-ops were roughly equivalent during the month, so neither category was solely responsible for the decline. The months’ supply of homes moved up from 5.0 to 5.2, which is roughly a month higher than the low point we saw in January. However, the level of distressed sales continues to decline—falling to 15% of the total.

(0) The FHFA house price index of homes financed with conforming mortgages rose a bit less than expected, at +0.8% versus +0.7%. From a regional standpoint, the South Atlantic/Florida area led with a gain of almost 2%. For the year-over-year period, the index rose +7.3%, with the Pacific region leading all areas with a gain of nearly +16%, followed by the Mountain area with a +13% increase. The index still remains below the pre-crisis peak, however.

(+) New home sales rose +8.3% in June, besting forecasts of a smaller +1.7% gain; however, some revisions downward for prior months accounted for some of the difference. While sales increases generally took place nationwide, the Midwest saw a bit of a decline on the month. The months’ supply of new homes dropped by a few tenths to 3.9, to a new post-recession low, although overall sales levels continue to be below pre-recession levels. June’s results brought the year-over-year gain in new home sales to +38%, which continues to be indicative of a strong recovery trend in housing.

The impact of interest rates on mortgage activity has been discussed at length by a few economists lately, but the conclusion is inconclusive. Rates have risen by about a percentage point from early May to the end of June. In general, the rule of thumb is that a rate increase of 1% leads to roughly -10% lower home prices and a -10% drop in housing starts, at least historically. But, this is based on several other factors, such as relative rate levels, general affordability and availability of credit. Rates have been so low for so long now, that many homeowners who wanted to (or could qualify to) refinance have likely already done it, so the ‘refinancing burnout’ effect may have already played out to a certain degree. If rates move significantly higher, though, the impact could serve as somewhat of a headwind to continued construction and peripheral housing-related activity. Such an extreme case may be a stretch at this point.

(0) Initial jobless claims for the July 20 ending week rose to 343k, which came in higher than consensus estimates of 340k. Continuing claims for the July 13 week reversed their recent rise and dropped to 2,997k, below estimates of 3,025k. Seasonal adjustments common this time of year, such as in the auto industry, appear to be a continued factor in claims.

On another side note, the U.S. budget deficit is certainly shrinking. After exceeding $1 trillion for each of the past several years, the Congressional Budget Office expects it to drop fairly dramatically this year to $600-700 billion for the fiscal year ending in September. The impact is from both sides of the equation: higher tax revenues during a slow economic recovery, as well as lower expenditures from a fiscal austerity. From a relative size standpoint, the ratio of deficit-to-GDP ranged in the 2.5% area from 1980-2007, then peaked to over 10% in 2009 before falling to just below 5% this year. This is the fastest decline since the one following World War II. According to government projections, the deficit is predicted to fall to just under $500 billion by 2018, but may begin to rise yet again if no adjustments to Social Security and Medicare are made in the meantime.

While positive for America’s credit rating, it also has some impact on debt markets going forward. The U.S. will be issuing less Treasury debt, at perhaps higher rates in future years, which has the impact of raising overall interest costs. At the same time, smaller issuance constraints supply, thereby potentially pushing prices up and yields down from a simple market participant supply/demand dynamic. These budget estimates are continually revised, but it appears the debt-to-GDP ratio may have reached its peak.

Market Notes

Stocks recovered towards the end of the week to a generally flat result, as earnings reports continued mixed. Technology and health care performed best, while consumer staples and industrials lagged by the largest amounts. From a newsworthy standpoint, Apple positively surprised, as did Facebook, dramatically sending those shares 25% higher at one point. However, there were some disappointments to temper the higher-profile results, such as Microsoft’s -12% drop, as reports have become much more stock-by-stock dependent. On a net basis, the S&P earnings picture has featured 70% of firms performing positively, with about half reporting so far. Interestingly, Lipper noted the 29th consecutive week of equity mutual fund inflows ($3.3 billion last week).

One important trend in the technology space, alluded to in Facebook’s results, is that mobile devices have been increasingly encroaching upon the share long held by traditional PC’s in terms of usage and, ultimately, revenue. Interestingly, we recently came across a research report titled ‘mobile device exhaustion,’ which is an arcane topic in itself but serves as a reminder of the hyper-focus on micro factors in this subset of the tech sector.

The bottom line: while devices can get increasingly smaller and faster, we can only handle so many of them at one time, and can only take advantage of so many features (video, camera, internet, etc.) before the marginal utility of a newer, fancier device eventually wears off. Eventually that trend may begin to decelerate more dramatically (as it has in developed nations, although there is some room to go in emerging markets). This is the behind some of the fear that has likely affected performance of firms like Apple in recent quarters, as well as that of peripheral suppliers.

In foreign markets, Spain and Italy recovered strongly, as did China and Greece in a week that favored the recently downtrodden nations. Japan, Turkey and Russia were the poorest performing major nations on the week—in Japan’s case, much of the weakness was the result of a stronger Yen.

Chinese premier Li announced the government is aiming for 7.5% GDP growth for 2013, but won’t permit it to drop below 7%. Despite the lower target (compared to recent years), markets were generally happy with the decisive nature of the pro-growth stance. Tools in this stimulus effort include high-speed railway construction in lesser-served areas, as well as keeping currency appreciation on the yuan tempered—to keep burdens on exporters in check.

In the fixed income world, yields bumped up again a bit on the week with almost $100 billion in new Treasury supply, causing shorter-term bonds to outperform the longer-duration variety. Developed market international bonds also performed well on the week, while high yield and emerging market debt sold off, as did long treasuries.

European real estate was the only positive performer in that asset class for the week, while Asian and U.S. REITs lost ground. Residential and mortgage REITs fared the weakest—down -2% generally.

In commodities, precious metals (gold specifically) recovered, with gains in the +2% area, while most other commodities ended up in the negative. Grains fared especially poorly again, with corn falling -10% on projections for a record forecast; soybeans and wheat also dropped in price with benign weather and a lack of drought conditions. Natural gas also experienced a downward move this week. Oil prices experienced a relatively non-eventful/flat week, despite Brent rising +4% and WTI up +7% so far in July as U.S. inventories have been drawn down. Refineries have also ramped up production, which has added to demand pressures on crude. These recent gains have been the first push above the trading range in over a year.